Should You Pay Off Your Debt Before Investing?
At an end of summer BBQ recently, a family friend and their 26 year old son were chatting with me and asked about my take on paying off debt prior to investing. They seemed to have very different opinions on this matter and so, without any knowledge of either of their financial situations, I answered with an apathetic “I guess it depends”.
But that question really got me thinking, is this a generational way of thinking? And is it that way because each generation has a different debt load? So, I went home and started doing some reading. I already knew that the “average American” has around $90k in debt, but who is the “average American” anyway? I found this table on debt.org that separated out the average amount of debt per generation:
GEN Z (ages 18-23): $16,043
MILLENNIALS (ages 24-39): $87,448
GEN X (ages 40-55): $140,643
BABY BOOMERS (ages 56-74) $97,290
SILENT GENERATION (ages 75 & up) $41,281
While these numbers reflect all types of debt, from credit cards to student loans, mortgages to personal loans, the numbers actually surprised me. Next I looked at the average debt based on annual income and it looks like this:
Average debt amount $12,600
Average debt amount $9,780
Average debt amount $6,990
Average debt amount $4,910
Average debt amount $4,650
Average debt amount $3,830
Annual income of $290,000 & up
Annual income of $152,000-289,999
Annual income of $95,000-151,999
Annual income of $59,000-94,999
Annual income of $35,000-58,999
Annual income of less than $34,999
These numbers reflect what we already assume, the more money you make, the more money you spend. The wealthier you are, the more apt you are to carry debt, but it is also easier to erase that debt. For some of the groups on the above lists, paying down their debt will often be more difficult. And having an average lifespan in America of 79 years, your age may play a factor in this decision as well.
Ideally, you would go forward with a balanced approach serving both today's needs (eliminating debt) and tomorrow's goals (investing). And while each person's circumstances will be different in a variety of ways, below I have given some baseline information to help you decide how you would like to personally go about paying off your debt/investing your money.
First things first, we always encourage you to have an emergency fund. Traditionally, we are advised to save 3-6 months or more of living expenses in liquid assets. While this is the ideal amount, it can be hard to attain, so begin by ensuring you have at least one month of expenses with a goal of growing that amount over time.
After you have a plan to work on your emergency fund, you need to consider your future. Remember that decisions you make today will be most effective in helping you achieve your long-term financial goals in the future. Think about the money situation you would like to be in 10, 15 & 20 years from now. If you have the option to participate in a retirement plan through your employer, especially if your employer makes matching contributions, this is a more than compelling reason to create a plan to prioritize investing at least up to the amount that your employer will match. Also, if you have high-interest compounding debt, that could eventually snowball into something that could impede you from reaching your future goals. In contrast, you may not choose to quickly pay off a low interest debt if you have the potential to have good return on a long-term investment. It is also critical to keep in mind that you will certainly need to pay off the principal eventually, but your investment returns will never be 100% certain. Investment performances vary over time, and you can experience losses as well as gains. As I mentioned earlier, this is a scenario that will change incredibly from person to person, and it is always in your present and future selves best interest to talk with an advisor to crunch those numbers and create a plan with you.
After you have your emergency fund up and going and an investment strategy in place, you should start to decide how you can reduce your debts. A professional advisor can help you decide which debts to pay off first, but a general rule of thumb is: pay those high interest debts off first. Those interest amounts can start to rack up quickly and it’s never fun to pay a large company hundreds of your hard earned dollars if you don’t have to. Focus on those credit cards and private student loans. Once those are under control you can shift your energy to your vehicle loans. Mortgages and Federal student loans often have lower interest rates, and therefore typically a lower priority. Sometimes people need to feel more motivated with a “quick win”. If this is you, use an alternative approach of paying off your smallest debts first in order to mark them off. If you prefer this way of repaying, then make sure you take the payment amount of your paid off debt and add that amount to a different debt, to accelerate its pay off as well.
If you’re a person with debt that also is interested in investing, you’re definitely not alone. Your future self is just as, if not more important than your today self. Working with a financial advisor will help you make an attainable plan and set attainable goals. You can do both by investing in yourself and hiring a professional.
- Sylvia McCormick Burns (Co-founder Oakview Wealth Solutions)